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Big government, runaway inflation and a market bubble?

Not so fast. We dispel the three biggest concerns on investors’ minds.

Our Top Market Takeaways for February 12, 2021.

Markets in a minute

Welcoming the Year of the Ox

Today marks the start of the Year of the Ox. Fitting, because the combination of recovery dynamics and persistent policy support are pulling the market higher like oxen. Heading into Friday, the S&P 500, NASDAQ 100, MSCI World and MSCI Emerging Markets equity indices were all at all-time highs.

  • Positive S&P 500 earnings growth in the fourth quarter of 2020 looks all but certain—with ~70% of the index’s market cap having reported, earnings per share are estimated to have been +2.8% higher than they were a year ago (way better than what consensus was expecting).
  • We already knew that the U.S. housing market was booming, but data released this week showing a nearly 15% rise in single-family home prices in the fourth quarter (the largest increase in over 30 years!) validates the trend. All of the demand has drawn down housing inventories, so more need to be built. Real estate tends to have significant positive ripple effects throughout the jobs market, so this bodes well for the economy at large.
  • The United States made deals to deliver 200 million more vaccine doses to Americans, and President Biden said enough doses would be available to vaccinate 300 million Americans by the end of July.
  • House Speaker Pelosi said the next fiscal relief package is on track to be passed by the end of February, and Senate Majority Leader Schumer reiterated that the impeachment trial of former President Trump won’t hold up the timeline of the bill getting signed into law. We expect it to deliver at least another $1 trillion of support to the recovering U.S. economy, with meaningful risk to the upside.
  • Fed Chairman Powell reiterated the Fed’s continued support for the economic recovery and again called for help from the fiscal side. He also threw some cold water on the idea that fiscal stimulus might be too big.

So, all upbeat news. But is this a “too much of a good thing” kind of situation? What if all the stimulus causes the economy to run too hard, too fast, or what if the Fed’s ever-easy policy stance causes a spike in inflation, or what if the market is way ahead of itself and in a bubble that’s bound to burst?

Those are the questions dominating the conversations we’re having with investors. Below, we address each.


The questions on every investor’s mind

Q: Could the stimulus bill cause the economy to overheat?

A: Not anytime soon. Notable economists have argued that the Biden proposal for stimulus is too big. That might be true if we were designing the response to fit perfectly with the size of the output gap (or the gap between where the economy is and its potential), but we aren’t in a classroom.

In practice, we think we are a very long way from overheating. Most importantly, there is tremendous slack in the labor market. The employment-to-population ratio is the lowest it has been since the early 1980s. Don’t take our word for it, Jerome Powell is on the same page. And did you see the inflation numbers earlier this week? The core Consumer Price Index only rose 1.4% in January from the prior year (well below the Fed’s 2% target). No signs of inflation anywhere.

And speaking of the output gap, based on the CBO’s own estimates, the economy has been growing below potential two-thirds of the time since 1960.1 Maybe it’s time to try to get the economy to run hot.

Q: But stimulus will cause inflation to pick up at least a bit, right?

A: Well, yeah, but that’s the point. A pickup in inflation would most likely mean a healing economy. It means that more people are getting paid more money to spend on more stuff, which begets production of more stuff. Meanwhile, companies have to raise prices on their goods to maintain their margins.

But importantly, we don’t think inflation is going to spike overnight. Take two of the most important drivers of cyclical inflation: wages and shelter.2 As we said above, there’s still plenty of slack in the labor market, which means that wage growth won’t be offering much upward pressure anytime soon. The same goes for the cost of shelter—although home purchase prices have been on the rise, rents have declined throughout the pandemic. On the other hand, those sectors that could see surges in spending if and when life returns to more normal are only 9% of core Personal Consumption Expenditures.

We expect inflation to increase gradually, leaving plenty of runway for accommodative monetary policy. 

Q: How can I buy stocks when valuations are so high?

A: First of all, we think the stock market deserves its valuation. Second of all, higher valuations aren’t the only way stocks can appreciate.

On the first point, here are just three reasons why:

  • The earnings power of U.S. large cap corporations was resilient through the sharpest recession on record.
  • All-time low bond yields make stocks and their long-term potential look all the more valuable.
  • Corporate balance sheets are healthy, and bankruptcy risk is low. The Fed’s willingness to backstop the entire IG corporate bond market has played a large role in ensuring companies have access to capital.

On the second point, remember that stock market returns come from three sources: dividends, earnings growth and multiple expansion.

  • The dividend on the S&P 500 is 1.5% (1.9% for the MSCI World). Good news, you are already beating the yield on global aggregate bonds handily (0.91%).
  • We expect ~25%+ earnings growth for the S&P 500 this year (with risks skewed to the upside), and at least +15% earnings growth from all other major regions.
  • Sure, the multiple might contract a bit as interest rates rise, but we don’t think that will offset the earnings growth we will see through 2022.

The hope phase is probably coming to an end, but that means the actual growth phase is here. You don’t want to miss that, do you?


The Fifth Dimension

No, that’s not a reference to the late ’60s pop group famous for belting, “Come on and marry me, Bill!” (Although that might have been more apropos ahead of Valentine’s Day this weekend.) We’re talking about warped space, and a possible explanation for the existence of dark matter (which physicists think makes up most of the mass of the universe). The simple minds of we Top Market Takeaways writers kinda understand the fifth dimension as a place where electromagnetics and gravity meet (dimensions one through four comprise up/down, left/right, forward/back and time). The theory goes that particles enter this fifth dimension through portals and create the dark matter that isn’t currently explained by the standard model of physics. Researchers might just be that much closer to understanding how this all came to be and is. Neat.

All market and economic data as of February 2021 and sourced from Bloomberg and FactSet unless otherwise stated.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice


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1.You can read all about how the CBO estimates potential GDP here.
2.Our Macro Strategy Team assumes that along with momentum from the trailing year, wages and rents drive almost 90% of cyclical inflation.






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